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In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of assets. In the latter case it refers to allocating the cost of an
intangible asset An intangible asset is an asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive econom ...
over a period of time.


Amortization of loans

In lending, amortization is the distribution of loan repayments into multiple cash flow installments, as determined by an
amortization schedule An amortization schedule is a table detailing each periodic payment on an amortizing loan (typically a mortgage loan, mortgage), as generated by an amortization calculator. Amortization refers to the process of paying off a debt (often from a loan ...
. Unlike other repayment models, each repayment installment consists of both
principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academic officer of a university A university ( la, universitas, 'a whole') is an educational institution, institution of higher ...
and
interest In and , interest is payment from a or deposit-taking financial institution to a or depositor of an amount above repayment of the (that is, the amount borrowed), at a particular rate. It is distinct from a which the borrower may pay the len ...

interest
, and sometimes fees if they are not paid at origination or closing. Amortization is chiefly used in
loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
repayments (a common example being a
mortgage loan A mortgage loan or simply mortgage () is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any purpose while putting a lien on the property being mortgaged. T ...
) and in
sinking fund A sinking fund is a fund established by an economic entity by setting aside revenue over a period of time to fund a future capital expense, or repayment of a long-term debt Debt is an obligation that requires one party, the debtor, to pay ...
s. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end. Commonly it is known as EMI or
Equated Monthly Installment An equated monthly installment (EMI) is defined by Investopedia Investopedia is a financial website headquartered in New York City New York, often called New York City to distinguish it from , or NYC for short, is the in the United St ...
. :P \,=\,A\cdot\frac or, equivalently, :A \,=\,P\cdot\frac where: ''P'' is the principal amount borrowed, ''A'' is the periodic amortization payment, ''r'' is the periodic interest rate divided by 100 (nominal annual interest rate also divided by 12 in case of monthly installments), and ''n'' is the total number of payments (for a 30-year loan with monthly payments ''n'' = 30 × 12 = 360).


Negative amortization

Negative amortization In finance, negative amortization (also known as NegAm, deferred interest or Graduated payment mortgage loan, graduated payment mortgage) occurs whenever the loan payment for any period is less than the interest charged over that period so that the ...
(also called deferred interest) occurs if the payments made do not cover the interest due. The remaining interest owed is added to the outstanding loan balance, making it larger than the original loan amount. If the repayment model for a loan is "fully amortized", then the last payment (which, if the schedule was calculated correctly, should be equal to all others) pays off all remaining principal and interest on the loan. If the repayment model on a loan is not fully amortized, then the last payment due may be a large
balloon payment A balloon payment mortgage is a mortgage A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. Th ...
of all remaining principal and interest. If the borrower lacks the funds or assets to immediately make that payment, or adequate credit to refinance the balance into a new loan, the borrower may end up in
default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It ...
.


Amortization of intangible assets

In
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, amortization refers to expensing the acquisition cost minus the residual value of
intangible asset An intangible asset is an asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive econom ...
s in a systematic manner over their estimated "useful economic lives" so as to reflect their consumption, expiry, and obsolescence, or other decline in value as a result of use or the passage of time.
Depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in a ...

Depreciation
is a corresponding concept for tangible assets. Methodologies for allocating amortization to each accounting period are generally the same as these for depreciation. However, many intangible assets such as goodwill or certain
brands A brand is a name, term, design, symbol or any other feature that identifies one seller's good or service as distinct from those of other sellers. Brands are used in business Business is the activity of making one's living or making mon ...

brands
may be deemed to have an indefinite useful life and are therefore not subject to amortization (although goodwill is subjected to an impairment test every year). While theoretically amortization is used to account for the decreasing value of an
intangible asset An intangible asset is an asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive econom ...
over its useful life, in practice many companies will amortize what would otherwise be one-time expenses through listing them as a capital expense on the
cash flow statement In financial accounting, a cash flow statement, also known as ''statement of cash flows'', is a financial statements, financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the a ...
and paying off the cost through amortization, having the effect of improving the company's
net income In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a busin ...
in the fiscal year or quarter of the expense. Wikinvest's Coverage of Amortization Amortization is recorded in the
financial statements Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
of an entity as a reduction in the
carrying value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Trad ...
of the intangible asset in the
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such ...

balance sheet
and as an expense in the
income statement An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''statemen ...
. Under
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
, guidance on accounting for the amortization of intangible assets is contained in IAS 38. Under United States generally accepted accounting principles (GAAP), the primary guidance is contained in FAS 142.


See also

*
Amortized analysis In computer science Computer science deals with the theoretical foundations of information, algorithms and the architectures of its computation as well as practical techniques for their application. Computer science is the study of Algorit ...

Amortized analysis
*
Annuity (finance theory) An annuity is a series of payments made at equal intervals.Kellison, Stephen G. (1970). ''The Theory of Interest''. Homewood, Illinois: Richard D. Irwin, Inc. p. 45 Examples of annuities are regular deposits to a savings account, monthly home mortg ...
*
Depletion (accounting) Depletion is an accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be ...
*
Earnings before interest, taxes, depreciation and amortization A company A company, abbreviated as co., is a legal entity In law, a legal person is any person A person (plural people or persons) is a being that has certain capacities or attributes such as reason, morality, consciousness or self ...
EBITDA * Index of real estate articles


References

{{reflist, 30em Accounting terminology Real estate Loans Intangible assets